## Step 5 for Calulating a Weighted Average - Cost for each Product

STEP 5   -  DETERMINE YOUR COST(S) FOR EACH PRODUCT

To this point, we have used only percentages as our major forecasting tool. Now its time to determine the cost of each product you plan to sell.

Specific calculation of each product cost will depend on whether you are a manufacturer, a retailer, or a service provider. For instance, most retailers and service providers purchase products that are considered finished and ready for the public to purchase. In other words, when suppliers ship products to retailers and service providers, they require little, if any, alterations before customers can buy them. Therefore, retailers and service providers calculate their per unit product cost by determining the cost to purchase each product plus all costs required to ship the finished product to their place of business.

On the other hand, when manufactures receive their raw materials (unfinished products) from their supplier, they usually make substantial changes to it before the product is "ready" for consumer use. Such changes generally require labor. As a result, manufacturers must account for such labor costs as part of their product cost. Another cost most manufacturer consider in their product cost is factory overhead. Factory Overhead are costs associated with operating the production facility (where the products are produced and manufactured). By considering direct labor costs and factory overhead costs into the equation, the manufacturer can determine the actual cost of producing one "finished product". The following chart illustrates the items in which a manufacturer, a retailer and a service provider must consider when determining their product cost.

 Cost Items Manufacturer Retailer/Service Purchase of finished product/ raw materials Yes Yes Shipping of finished product/raw materials Yes Yes Direct labor to finish product Yes No Factory Overhead Yes No

In our clothing store example, John is considered to be a retailer. Therefore, in order to determine his product cost per unit he must consider two variables - 1) the cost to purchase each finished product (IE clothing) and 2) the cost associated with shipping each finished product to his place of business. Lets look at each variable separately.

In order to determine the cost of purchasing each clothing product, John is required to a find a supplier who can supply him with the brand name products he plans to sell. Lets assume, he contacted several clothing suppliers and requested information on the following items; their products and brand name selections, a price list, product warranties, product return policy, quantity discounts, supplier credit terms, and shipping terms (to name a few). After analyzing the information provided by each supplier, John selected "Fine Clothing Enterprises" as his main supplier. Below depicts the per unit cost of each product John plans to sell. (Please Note: assume the figures below were provided by Fine Clothing Enterprises)

 Denim Jeans Cost per Product Levi Jeans \$26.67 Edwin Jeans \$31.43 Guess Jeans \$28.57 Ikeda Jeans \$27.62 Casual Pants Dockers Pants \$23.81 Cream Pants \$26.67 Sweaters London Fog Sweaters \$23.81 Guess Sweaters \$26.67 Long Sleeve Shirt Polo \$15.24 Gasoline \$16.19 T-Shirts Hollywood \$ 7.62 Manager \$ 8.57 Belts Razzy \$ 9.52

As you see, the first column represents the products in which John plans to sell. The second column represents the price John will have to pay for each brand name on a per unit basis.

John knows that when he orders clothing from his supplier he will NOT purchase one unit at a time. Instead, he will purchase the products in bulk or blocks and may be granted quantity or volume discounts. But in order to objective, John plans to use each per unit cost as a foundation for his forecasting model. Some forecasters even increase the actual per unit cost in order to achieve greater objectivity. It is advised, however, you use the actual per unit cost provided by your supplier and do not consider any supplier discounts in your forecasts.

The second item John must consider is freight or shipping charges. Moreover, the per unit product costs, listed above, do NOT include the cost to ship each product or group of products to John's proposed business location. When talking with a supplier, be sure to inquire about shipping costs. The supplier will have lots of experience in this field and will be able to provide you with an estimated shipping cost percentage. Assume, John asked his clothing supplier for information on shipping charges. The supplier informed him that shipping costs within the clothing industry is usually 5% of each product's cost. Using this information, John can now estimate each product's total cost (IE Total Product Cost per item).  The following chart provides this information.

 Cost per Unit Shipping Cost 5% of unit cost Total Cost per unit delivered Denim Jeans Levi Jeans \$ 26.67 \$ 1.33 \$ 28.00 Edwin Jeans \$ 31.43 \$ 1.57 \$ 33.00 Guess Jeans \$ 28.57 \$ 1.43 \$ 30.00 Ikeda Jeans \$ 27.62 \$ 1.38 \$ 29.00 Casual Pants Dockers Pants \$ 23.81 \$ 1.19 \$ 25.00 Cream Pants \$ 26.67 \$ 1.33 \$ 28.00 Sweaters London Fog Sweaters \$ 23.81 \$ 1.19 \$ 25.00 Guess Sweaters \$ 26.67 \$ 1.33 \$ 28.00 Long Sleeve Shirt Polo \$ 15.24 \$ .76 \$ 16.00 Gasoline \$ 16.19 \$ .81 \$ 17.00 T-Shirts Hollywood \$ 7.62 \$ .38 \$ 8.00 Manager \$ 8.57 \$ .43 \$ 9.00 Belts Razzy \$ 9.52 \$ .48 \$ 10.00 * FIGURES ARE ROUNDED TO THE NEAREST CENT

The first column represents the cost for each brand name of clothing (IE Fine Clothing Enterprises' selling prices). The second column represents the cost John would pay to ship each product to his place of business (5% of selling price). The third column represents the total cost to purchase each product (including shipping charges). For instance, John estimates it will cost him approximately \$8.00 for each Hollywood T-shirt he orders. Therefore, if in the future, John orders 100 of these T-shirt, he knows it will cost he approximately \$800 dollars (100 x \$8.00 = \$800).

This concludes step 5 entitled "Determining Your Total Product Cost per unit.  The next step is to determine your selling price for each product you plan to sell.

Categories: Financial